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Thursday, March 31, 2011

With the eurozone destined for years of navel-gazing, as it struggles through the current sovereign debt and banking crisis, the UK is actually very well placed to push for EU reform. Its own economic challenges aside, Britain now has a chance to use the debt and competitiveness predicament facing several European countries and the EU as a whole as a springboard to get Europe back on the road to growth.

In other words, this could be turned into a benign crisis for those of us who are in favour of a growing and competitive Europe (it's hard to argue that Europe doesn't need reform when several countries are on the verge of bankruptcy).

Encouragingly, Downing Street has moved today to try and push this agenda, with a new initiative entitled "Let's choose growth" - and there's lots of good stuff in there (and the format is refreshingly innovative and easy to grasp, including this You Tube clip). Besides the proposals to liberalise the single market further, by creating a common market for digital and service industries and calling for deregulation, there also seems to be an emphasis on 'shock therapy'. Cameron and Co have made it plain to EU leaders that standing still is not an option as the rest of the world moves on.

This chart should be all the motivation Europe needs. As you can see, by 2050, only Germany and the UK are predicted to remain among the world's economic elite, and they will only be hanging on to the bottom two rungs of the ladder.

The rise of the likes of China, India and Brazil is inevitable but this is no excuse for Europe to give up. The big question however is whether the UK and other like-minded governments, such as the Scandinavians, the Dutch and the Czechs, will be able to keep the eurozone's attention long enough to make the point.

For this to happen, the British government needs to roll up its sleeves and get down to business: form alliances (cultivate, cultivate, cultivate the Scandies, new members - and the biggest prize of them all - Germany), horse-trade, manage the European Parliament, convince through pursuing best practice at home (such as the 'Better Regulation agenda', and a strong, healthy economy), on EU proposals get in early and get in low - but be tougher and shrewder when negotiations get rowdy.

Downing Street should be given credit for raising its game on EU reform. But now it must show it can turn a catchy pamphlet into concrete action.

Wednesday, March 30, 2011

In a speech in Oslo today, EU President Herman Van Rompuy talked about the sound fundamentals of eurozone economies. He references the average growth of 2%, the average deficit of 4.5% and the strength of the euro as evidence for his claim.

To his mind these are the "basic facts".

Well, we think it might be worth reminding him of the basic nature of averages. If you have two very divergent groups (the core vs. periphery eurozone economies) the average will be somewhere in the middle and will be of little use – it may even be misleading.

Take two people, one about to fall off a cliff (Greece, Ireland, and Portugal) and another standing a fair distance away (Germany, Finland etc), on average their position from the edge of the cliff will not sound too bad but this misses the point that one of them is in dire straits. Add to this analogy the fact that the two are tied together by a rope (the single currency), and the situation clearly is not how it sounds under Rompuy’s becalming "basic facts" scenario.

As for the strong euro, this is another misleading point. It is being maintained by the spectre of imminent ECB rate rises, which would be detrimental to many of the peripheral eurozone economies – due to high private debt and lack of lending in the economy (not to mention encouraging further current account deficits). In our scenario this introduces a third person (the ECB) who is chipping away at the cliff beneath the first person’s feet (precipitating their fall).

To convey the basic facts of a system as complex as the eurozone you need to go deeper than averages.

“We will not be banning cars from city centres any more than we will be having rectangular bananas. It is right that the EU sets high-level targets for carbon reduction, however it is not right for them to get involved in how this is delivered in individual cities.”

The German Car Industry Federation called the proposals "planned economy methods from the old days".

Dutch mobility federation Bovagmade the point that "2050 is too far away. Nobody can look so far ahead. But if you look now at where electronic cars stand there isn't really a rush."

The last point is really the main issue for us: why is the EU trying to create policies for 40 years time? It is impossible to predict what the exact needs of people will be in 2050, especially in urban transport, a sector which has been developing quickly over the past few decades. Any elected official worth his salt would not bother with a policy such as this, the EU would fair far better by trying to tackle the mountain of problems it faces now - the sovereign debt crisis, the banking crisis and a growing bribery scandal.

People 40 years ago predicted we'd all be in flying cars by now, maybe the EU should start planning for that...

After three meetings, Zalban actually put forward one amendment, out of two, that the undercover journalists suggested.

“One of these I rejected, but the second, after consulting with the assistants from the EPP, we thought it would enrich and improve the report because it protects small investors and goes in the same direction of consumer associations, and for this I incorporated it”, he said.

Standard & Poor’s yesterday downgraded both Greek and Portuguese debt by one notch and kept them on negative outlooks. That hints at further downgrades in the near future, although given the extent of the problems in both countries that could be as soon as next week.

More interesting to us, is the reasoning behind the downgrade. S&P directly puts its decision down to the agreement which was reached on the permanent bailout fund (ESM) at last week’s EU summit. In particular, the fact that, as expected, ESM debt will be senior to all private debt and taking loans from the ESM may be conditional on restructuring debt. S&P suggests this could be “detrimental to commercial creditors”.

Investors feared ESM uncertainty, but if there’s one thing markets hate more than uncertainty, it’s having their fears crystallised by government policy. The ESM undoubtedly makes peripheral government bonds more risky to hold and was always going to be met with a downgrade and higher borrowing costs. The real questions remain: Why did EU leaders decide to announce this two years in advance, thereby massively prolonging and increasing the pain of peripheral economies? And at the same time why did they put off dealing with the temporary bail-out fund, the EFSF?

There's still no agreement on how to top up the EFSF, which in turn makes investors doubt the EU's capability to deal with future bail-outs. Sorting out the EFSF might have helped limit the fallout from the ESM decisions; in any case it makes no sense to delay the more pressing of the two issues. Flagging up the fact that debt restructuring may be possible down the line somehow manages to simultaneously ignore the fact that it should be done sooner while also increasing the need for it.

Eurozone countries continue to complain about rating agencies' actions – which are admittedly far from perfect – but maybe they should stop throwing fuel on the fire.

While the principle behind it is very much welcome - putting the burden on taxpayers rather than investors - due to poor sequencing and timing, the ESM has managed to fail before it even came close to starting. That’s impressive even for an EU policy.

Monday, March 28, 2011

Alistair Darling hit out at David Cameron and George Osborne today for trying to put all the blame for the UK’s participation in the €60bn European bailout fund (the EFSM) onto the previous Labour government.

Darling said:

"When you referred to the discussions that took place in May of last year in relation to the eurozone fund, you gave a somewhat incomplete account of my conversation with the now Chancellor (George Osborne),"

"We did indeed agree that we should do everything we could to keep Britain out of the main part of the rescue fund.

"But in relation to the smaller element [the EFSM] which you refer to, what we discussed was not voting against but abstention, recognising that Britain could have been out-voted - exactly the same thing that the Chancellor referred to when dealing with Ireland.”

It has been known for some time that Darling consulted Osborne before effectively nodding through the deal, but this is the first time the former has gone public with what actually happened during that extraordinarily eventful weekend back in May. Cameron and Osborne may argue that they could have been outvoted and dragged into the bailout fund anyway, but that’s not really the point. By agreeing to abstain - it that's what they did - and essentially condoning the UK’s participation in the bailout mechanism, they can hardly claim that it was all down to the Labour government and that they're therefore innocent victims of a deal struck before their time.

This whole situation is indicative of the Coalition’s approach to some of key challenges facing Europe at the moment – steer clear of controversy by shirking responsibility. Well, with a potential Portuguese bailout looming as well as new budget negotiations on the horizon it’s clear that the government will be forced to engage with the EU and make some decisions soon; they would look a whole lot better if they started taking the initiative.

Pushing for an alternative route for Portugal - a restructuring combined with a limited cash injection so that more of the burden fall on investors and less on taxpayers - would be a good place to start.

Friday, March 25, 2011

This week's fun and games are over, with EU leaders concluding their Brussels summit earlier this afternoon.

Once again, this summit is unlikely to be remembered for anything EU leaders could agree on but, rather, for what eurozone leaders, in particular, were unwilling to even discuss. Namely, getting to the root of sorting out the eurozone's short-to-medium-term future.

Why, within the space of 12 days, do we get a "grand bargain" to create a Euro Stability Mechanism (11 March), which is then (a) knocked back by Finland (b) defied by Portugal (c) renegotiated at the behest of Germany's FDP coalition partner so they can do a tax giveaway in the coming elections; and (d) excludes Ireland anyway?

Chancellor Angela Merkel's, and by extension Germany's, focus on what are, in the grand scheme of things, minor details is starting to betray a worrying resemblance to an obsessive-compulsive's inability to recognise the bigger and far more important realities in life. Merkel's two 'victories' from this summit appear to be the fact that Germany will now pay in its share of capital to the permanent post-2013 eurozone bailout fund over five years rather than four and an EU commitment to "stress test" nuclear power stations. These are both pretty obvious bones thrown to the domestic German audience - the SPD and Greens are breathing down the neck of Merkel's CDU party in important regional elections - but will do little to reassure people that the eurozone is serious about tackling its problems. Not for the first time, domestic politics is pitted against eurozone imperatives.

True, the proposals on economic governance and tighter fiscal discipline were broadly endorsed, but earlier German proposals have been watered down and there's still much to play for in regards to how much of the package will be credibly enforceable. How will Italy and Greece cope with demands to get their debt-to-GDP below the 60% threshold?

Partly also due to Finnish resistance, eurozone leaders were unable to reach agreement on how to top up the existing temporary bailout fund, which, with Portugal more or less in a state of political and economic crisis seems a little complacent to say the least. We're told that all will be settled at the next summit in June - but haven't we heard this before; "It will all be sorted next time, no need to worry".

Maybe Merkel and the rest of the eurozone's leaders just prefer working under pressure. June really will be cutting it fine: Portuguese elections are expected to have been held only a week or so before and the new attempt at credible stress tests for Europe's banks are due to be published.

There have been lots of numbers floating around on what a bailout of Portugal would mean for the UK. The tabloids today reported a figure of €6.8 billion, while on the BBC Today programme, Robert Pestonargued that Britain would only contribute through the IMF, and possibly nothing at all.

Please bear with us as we're trying to break down what's going on here.

First, any bailout would NOT be a direct cost imposed on the UK, apart from the cash contributions the country is making to the IMF. The UK would be liable for a possible bail-out under the the so-called European Financial Stabilisation Mechanism, which the Labour government signed up to in the dying hours of its administration. The mechanism involves the European Commission borrowing money on the markets and then lending it to struggling eurozone countries, using the EU budget as collateral. So far, only Ireland has tapped this fund (Greece only recieved money from the IMF and the bail-out fund that only eurozone members contribute to, the EFSF). Since the UK contributes to the EU budget, it guarantees a certain portion of the loans given to any bailout recipient under the EFSM (the UK's share is around 13.6%). However, this is still significant for UK taxpayers, as it effectively requires them to underwrite the debt of peripheral eurozone economies. It's a bit like if you were to underwrite the mortgage of your neighbours house.

Secondly, in terms of the size of these liabilities, we expect a bailout of Portugal to be in the region of 60-€70bn - though we've seen figures of up to €100bn floating around(clearly its a moving target which makes it difficult to predict). If Portugal needs a €70bn bail-out and the rescue operation is structured in the same way as the loans to Ireland were - one third each from the EFSM, EFSF and IMF - the UK’s liabilities would be €3.2bn (13.6% of the total) under the EFSM and €1.05bn under the IMF. This gives a total UK liability of €4.25bn (if the bail-out is restricted to €60bn, then the UK's liabilities will be in the region of €3.7bn).

Are you with us? Pardon all the acronyms - but this is EU policy, remember.

Thirdly, this is assuming that the EFSM - which, again, the UK is partially underwriting - is in fact activated and used. If EU leaders decide to only look to the IMF and the EFSF, we're looking at a different scenario.

So, the question is, will the EFSM be used in a Portuguese bail-out? The BBC's Robert Peston gave no explanation on the Today programme for his assertion that the UK wouldn't be implicated in a rescue operation on the Iberian peninsula. However, on his blog, he seems to suggest that the EFSM will only be used once the eurozone-only fund, the EFSF, has been exhausted (which it won't be in the case of Portugal).

This is a possible scenario (as we explain in our Portugal briefing) - which will clearly limit the UK's liabilities - but it involves some pretty heroic assumptions. EU leaders are currently bogged down in hugely complicated talks over how to boost the fire power of the EFSF (the fund is currently worth €440bn on paper, but a lot less in reality) in order to convince markets that the eurozone has what it takes to save the euro. A deal is currently being blocked by Finland, due to domestic opposition to underwrite the debt liabilities of other countries, with Finnish national elections looming.

Only involving the EFSF and IMF in a bail-out would leave the EFSF almost completely tapped out. And if markets suspect that the EFSF is runing dry, the euro might be in for an even bumpier ride. Therefore, there will be many EU leaders out there who will want to use a large chunk from the EU-wide EFSM (which still have €37.5bn in it).

In addition, the EFSM is much faster to get off the ground as, unlike the EFSF, it's decided by majority voting. The case of Finland (and also Slovakia which refused to take part in the Greek bail-out), shows why this matters. Ergo, there is a very strong case for suspecting that the EFSM will be used, and therefore, that the UK will become indirectly liable.

That Peston seems to be omitting this discussion - which touches on so many important aspects of the ongoing eurozone crisis - is surprising.

Fourthly, the UK tabloids today featured pieces on what would happen if the EFSM was tapped completely (i.e. if it used all the remaining funds). Well, there is currently €37.5bn left, of which the UK is liable for €5.17bn. However, it's very unlikely that this entire amount will used in a Portugal bailout, since the cost will be shared with first, the IMF and most likely also the EFSF. Our estimates that we set out above are far more likely.

Thursday, March 24, 2011

The Portuguese Prime Minister Jose Socrates resigned last night, after failing to get his new austerity measures through the Portuguese Parliament. This has pushed Portugal into a political crisis, and forced them to the brink of asking for a bailout.

As our new briefing on Portugal’s economic situation shows, a bailout could amount to €60bn - €70bn. Based on the structures of previous bailouts, the UK’s contribution could amount to as much as €4.26bn in liabilities (in the form of loan guarantees). That’s a big liability for taxpayers.

That’s why we argue for a combination of a restructuring and bailout. This would shift some of the burden onto investors; it would also help put Portugal on the road to debt sustainability rather than just recycling more debt around the EU.

For you restructuring-phobes out there, we are aware of the risk of contagion, but we believe there are many factors in this instance which make this a viable course of action:

- The bailouts of Greece and Ireland have solved little, they still have no market access to fund themselves and face ever increasing debt burdens.- Markets are already boycotting peripheral eurozone debt, how much worse can things get (if it wasn't for the ECB, Portugal would have gone bust long ago)!- Portugal’s debt burden, although large in GDP terms, is relatively small in nominal terms (given the size of other EU countries and banks).- Exposure to this debt is spread around the EU and does not fall heavily on peripheral economies; the European banking sector will withstand the losses it may incur (although if it coincides with other negative banks may start to wobble - but that's an argument in favour of sorting out the banks!)- The ‘Portugal goes, Spain goes’ assumption looks to be overstated (see positive market response to Spain despite Portuguese problems). In any case a limited bailout fund should help halt the spread of contagion from Portugal.- Unfortunately, we’re in a crisis; difficult decisions need to be taken. A restructuring now is preferable to a more costly one later. The alternative is ongoing transfers of wealth to struggling eurozone economies - the sudden rise of the "True Finns" in Finland shows why this is politically very unlikely.

The question that now needs to be answered is when can or will any of this take place? That depends on what powers a caretaker Portuguese government has, but, in our view, the sooner the better. (The double standards displayed by the opposition in bringing down the government over austerity measures, then pledging to do a better job of managing the debt and deficit levels, doesn’t fill us with confidence though).

Wednesday, March 23, 2011

The EU’s fledgling External Action Service has regularly been mocked for its naivety and ‘Kum-bay-ah’ approach; all too often it seems to base its polices on projecting a positive image of the EU, occasionally backed by some suitably bland statements, supposedly helping autocrats and dictators around the world to see the error of their ways and embrace reform.

It seems however, that the recent unrest in North Africa and the Middle East has brought a hitherto hidden Machiavellian tendency in the EU’s foreign policy to the fore. Firstly, we had the Maltese EU Commissioner for health going off-message on Libya a couple of weeks ago by saying he “didn't think [he] had the right, or anyone else, to make a statement on whether he [Gaddafi] should step down”.

Now Robert Cooper, senior advisor to EU foreign affairs chief Catherine Ashton, has claimed Bahrain is normally "a rather pleasant, peaceful place", and defended its security forces after they opened fire on protesters with live ammunition last week:

"I'm not sure if the police have had to deal with these public order questions before. It's not easy dealing with large demonstrations in which there may be violence. It's a difficult task for policemen. It's not something that we always get right in the best Western countries and accidents happen”.

His statement ought to be seen in the context of an earlier work in which he claimed:

“The challenge of the postmodern world is to get used to the idea of double standards…When dealing with more old fashioned kinds of states outside the postmodern continent of Europe, we need to revert to the rougher methods of an earlier era – force, pre-emptive attack deception, whatever is necessary… Among ourselves we keep the law but when operating in the jungle, we must also use the laws of the jungle”

This also follows the reports that another Ashton aide was briefing against a no-fly over Libya, which briefly put her at odds with both Cameron and Sarkozy, until it was explained away as a 'rogue briefing'.

These kinds of ill-advised comments emanating from the EU apparatus, and the fact that we'll never know who authorised them, demonstrate inconsistency, and further undermine the EEAS's objective of getting Europe to "speak with one voice". They also underline the potential danger of a power struggle over the EU's foreign policy at a time when Europe is facing an uncertain future.

Eurozone leaders seem intent on making their crisis resolution as messy as possible. According to draft summit conclusions, seen by Reuters, the decision on how the EFSF will increase its lending effective lending capacity to €440bn will be delayed until June.

Clearly the months of pitching this week’s EU summit as the defining moment in solving the eurozone crisis were not well thought through or just wishful thinking. The markets' reaction to what is now destined to be a seriously underwhelming agreement is likely to be painful for the peripheral eurozone economies.

Discussions will now focus on the ESM, which is not due to come into force until 2013. Crisis management 101 (for the EU officials out there) – handle the problems on your plate first, then deal with the ones coming down the line. Not that an agreement has been finalised on the ESM either, with German Chancellor Angela Merkel looking to score a more gradual timeline for Germany’s contributions to the fund, probably given the increasing pressures her party is facing in this year's local elections.

Not one to be topped, Portuguese Prime Minister, Jose Socrates walked out of Parliament in the middle of possibly the most important vote in the country's recent history. According to Portuguese press reports, he left without saying a word and no-one knows if or when he will be coming back.

No, we're not joking. Austrian MEP Ernst Strasser who was secretly filmed boasting to journalists, “Of course I’m a lobbyist, yes” will be succeeded by a two-times former MEP who runs his own lobbying firm.

Who better to replace an MEP disgraced for agreeing to amend EU laws on the promise of €100,000?

Strasser, who resigned after the Sunday Times released videos of him agreeing to propose amendments to EU laws for a €100,000 consultancy salary, is being replaced by Hubert Pirker, who himself worked as a professional lobbyist since leaving the European Parliament in 2009. He was an MEP from 1996-2004 and from 2006-2009.

The website of Pirker’s former consultancy firm “EU-Triconsult” has been removed from the internet, but under the firm’s services he offered prospective clients “my networks and my negotiation and lobbying experience with European and international institutions at your disposal.”

Meanwhile, the Romanian MEP implicated in the Sunday Times ‘cash-for-laws’ sting, former Foreign Minister Adrian Severin, has been expelled from the Socialist group in the European Parliament but has refused to resign from his post as an MEP. The third MEP involved in the scandal, former Slovenian Foreign Minister Zoran Thaler has resigned.

We asked yesterday whether the EP is reformable. This is not a good start.

Tuesday, March 22, 2011

We've consistentlyquestioned the logic of sending taxpayers' money from Paris to Berlin via Brussels in the form of the EU's regional (or structural) funds. It seemingly makes little sense for taxpayers in economically comparable countries to subsidise each other's regional policies, only minus the Brussels admin fee.

And it turns out that the search for a logical explanation was all in vain, as, according to German MEP Markus Pieper, the use of EU-channelled money to co-finance projects in relatively wealthy member states is completely justified because it contributes towards making the EU more visible to citizens.

"In countries like Germany, France and the Netherlands, Europe shows its face through local projects in the regions," he said.

This is the kind of argument you might expect to hear from the Commission or an MEP from one of the net recipient countries, but coming from a member of Chancellor Merkel's CDU party, which is making some pretty loud noises about fiscal prudence at the moment, makes it quite odd.

And it's not like the Commission doesn't already have a sizeable pot of money to spend on EU PR.

But the Sunday Times' investigation published yesterday, now dubbed the 'cash-for-laws' scandal, leaves three MEPs standing accused of outright corruption. The article is behind the paywall, and well worth reading in full if you get the chance, but here are the key details:

- Three MEPs, Adrian Severin, the 56-year-old former Romanian deputy prime minister, Zoran Thaler, the former Slovenian foreign minister, and Ernst Strasser, a former interior minister in Austria, were all caught agreeing to propose amendments to EU laws believing they would be paid for this work with a €100,000 (£87,300) annual salary, a consultancy fee or both.

- The meetings with undercover journalists were secretly filmed and took place in bars, restaurants and the parliament’s two buildings in Brussels and Strasbourg. Severin later emailed the reporters saying: “Just to let you know that the amendment desired by you has been tabled in due time." Then sent an invoice for €12,000 for “consulting services concerning the codification of the Directive 94/19/EC, Directive 2009/14/EC and the amendments thereto”.

- The amendments were intended to dilute directives supposed to protect customers’ deposits after scandals such as the collapse of the Icelandic banks.

The sting has already claimed the heads of two of the MEPs, with Austrian MEP Strasser resigning immediately but claiming this was to avoid "damage" to his Austrian People's Party rather than because he'd done anything wrong.

Severin and Thaler, said that they knew it was a set-up and merely wanted to see where the exchange of emails would lead and initially refused to resign but, according to the latestreports, Thaler has now also done so. Severin has quit his job as deputy chairman of the Romanian Social Democracy Party, but so far held onto his seat at the European Parliament. The Group of European Socialists in the EP has however ordered him to Brussels to explain himself.

As the Sunday Times argued in its leader, this comes at a time when:

"The European parliament and its 736 members matter more now than at any time in its 53-year history. We live in an era when much of British law and a high proportion of the regulations that control our lives are determined in Europe. MEPs have the power to amend those laws and directives in a way that affects everybody."

The EP is launching its own investigation but, if they're found guilty and perhaps even if not, this particular story is shocking enough to engrain the 'gravy train' image of MEPs in the public's mind's eye for good. Various attempts to 'reform' the EP (back in 2009 there were some harmonisation of rules on pay and a ban on hiring family members as staff) have clearly done nothing to stop the rot.

One can't help thinking that the real root of the corruption and general money-grabbing behaviour of many MEPs is the fact that the EP still thinks that it can behave like a banana republic assembly without anyone noticing.

Perhaps MEPs should forgive people for taking the view that the EP, at the end, is not a 'real' Parliament. This was the conclusion of the German Constitutional Court, which said in its ruling on the Lisbon Treaty that:

"Measured against requirements placed on democracy in states, its election does not take due account of equality, and it is not competent to take authoritative decisions on political direction in the context of the supranational balancing of interests between the states. It therefore cannot support a parliamentary government and organise itself with regard to party politics in the system of government and opposition in such a way that a decision on political direction taken by the European electorate could have a politically decisive effect. Due to this structural democratic deficit, which cannot be resolved in an association of sovereign national states (Staatenverbund), further steps of integration that go beyond the status quo may undermine neither the States’ political power of action nor the principle of conferral."

Unfortunately, with the implementation of the Lisbon Treaty in particular, the EP now has extensive powers over laws that impact on people's everyday lives.

Scandals such as these will prompt more people to suggest that it's time to move on from the argument about getting rid of just one of the EP's extra seats in Strasbourg and consider scrapping the entire thing...

Looks like Portugal could be asking for a bailout by the end of the week.

Pedro Passos Coelho, Leader of the main opposition party, said on Saturday:

“We need external aid. The Prime Minister does not want to admit that, but the whole country has already understood it.”

He also said he will continue to oppose the new austerity measures, which are due to be voted on by the Parliament tomorrow or Wednesday.

Portuguese Prime Minister, Jose Socrates, announced that:

“Should the Parliament vote against, then the government would no longer have the means to act.”

With massive public protests against austerity in Portugal over the weekend, there seems less and less political incentive for the opposition to cave in and support the new measures. The only thing that everyone seems to agree on is that if the new austerity measures are voted down, Portugal will be forced to ask for a bailout.

However, given Socrates stance the government may fall if he fails to garner the support he needs.

That does not bode well given the EU summit at the end of the week. Socrates needs to get his thinking cap on…as going into summit negotiations without a government cannot be a good strategy.

Having doubts is not shameful and I don't see why we are supposed to think that Germany should have supported the resolution simply because Britain, France and other countries were doing so.

Perhaps I'm missing something, but if sovereignty means anything it must permit sovereign, friendly nations to disagree on matters of major international importance. (And if the Germans are bad europeans for preventing a common EU approach doesn't that just mean they're fulfilling the traditional British role? Which in turn means they must, from the eurosceptic position, be the Good Guys in this instance.)

Germany's aloofness when it comes to matters of foreign policy and military action can be extremely frustrating. Take its unwillingness to get fully involved in Afghanistan, despite providing the third largest contingent of NATO troops, as an example. The legacy of the Second World War still looms large in the German psyche and that is somewhat understandable.

But, whatever one's views about the merits of Germany's perceived pacifism, Massie makes surely the most important point: that countries should be free to make up their own minds and, if they disagree with each other, so be it.

The real problems arise when you try to force these different views through the funnel/sausage machine that is the EU in the hope of a single common position.

At last week's summit, we should remember, it was Germany that blocked EU endorsement of a no-fly zone. This, in the words of the Independent, left France and the UK "isolated" in their call for intervention. This was, of course, nonsense because, as we have seen, it was never going to be the EU that decided on the use of force. The Franco-British defence pact, agreed last year outside the auspices of the EU, was an admission - however small - on the part of France that to get things done militarily, the EU is just too slow, indecisive and unwieldy.

And it was the Frankfurter Allgemeine Zeitung that today noted "the tensions in foreign policy between France and Germany are remarkable," adding that the lack of Franco-German consensus was "paralysing the EU".

The Franco-German relationship will always be the most important in the EU (they share a border, a turbulent history and the same currency), but on more and more issues, be it defence or the future of the euro, as France and Germany get up close and personal, the more they start to grate with each other. The FAZ article started by noting that newly appointed French Foreign Minister Alain Juppe's first visit to Berlin was cancelled, albeit with the "plausible excuse" that he had to fly to the UN in New York.

Alright, it's only in one area, and hopefully it won't come to the use of force, but if France begins to see the benefits of a flexible approach to European cooperation, sometimes outside the EU, this could prove to be important in breaking down the EU's monolithic approach to many other issues.

Business Secretary Vince Cable today announced a plan to ease the burden of regulation on small businesses in a bid to boost the economy. The plans would include a three-year break for small businesses from new regulation in addition to scrapping plans for extending parents' right to request flexible working and scrapping new rights for time off to train. The government has also vowed to review some 22,000 existing government regulations on business, with ministers forced to justify maintaining any that are challenged.

Now this is all welcome stuff, but the government has managed to completely ignore the regulation factory numero uno - that is Brussels - instead opting for a "can't touch this" approach.

When it comes to business, the EU is the main driver of regulatory cost in the UK. EU regulations do come with benefits, we don't deny that. But a lot of it is unnecessary or overly burdensome.

We can argue about the counterfactual (i.e. would the regulations have existed in the UK anyway), but what becomes clear during exercises like these is the extent to which the UK (and other member states) have lost control over their own regulatory reform agendas, as a huge number of laws are now locked in at the EU level. Changing an EU law requires re-negotiation and agreement amongst 27 different member states and the regulation-obsessed bunch that is the European Parliament.

Despite the fact that scrapping or amending unnecessary EU regulations could save the UK billions of pounds each year, and generate billions more in various dynamic effects, the Coalition has chosen to look the other way.

The problem with this approach is the familiar dilemma: you can leave EU regulation alone, but EU regulation will never leave you alone. The recent extension of the Gender Equality Directive by the ECJ to ban price differentiation between men and women should serve to illustrate this point (a ruling expected to cost the UK insurance industry an additional £1 billion).

We've been looking at the cost, proportion and impact of EU regulation in greater detail than most (see here, here, here, here, here, here for example). Just a reminder of our latest report on the topic: based on 2,300 of the Government's own regulatory impact assessments we've estimated that in 2009, 59% - or £19.3 billion - of the total cost of economic regulation (introduced since 1998) in this country stems from EU legislation. Cumulatively since 1998, EU laws account for £124 billion, or 71%, of the total cost.

And here are a few graphs showing the regulatory cost stemming from the EU to the main departments dealing with business regulation:

It's hard to better illustrate why any attempt to tackle regulation that doesn't focus on the EU level simply isn't credible. We would be lying if we said that the Coalition's refusal to engage with EU regulation doesn't frustrate us. In fact, we'll soon publish a list of EU laws that the Coalition must seek to re-negotiate. So do watch this space.

As we've highlighted before, a bust-up in Germany over the fate of the eurozone's bail-out schemes could be imminent, both on the EFSF and its permanent successor.

As if Merkel didn't have enough on her hands, the Bundestag yesterday approved a motion that explicitly demands that the German government bans the EFSF from buying government bonds from troubled eurozone countries. In effect, the Bundestag is asking Merkel to backtrack on last weekend's agreement between eurozone leaders which would have given the EFSF the mandate to buy bonds directly. That's a pretty big set-back for the Chancellor.

The motion isn't binding for the government, but still hugely problematic since the Bundestag needs to approve any deal to increase the scope and size of the EFSF.

The vote illustrates the growing gaps between Angela Merkel and parliamentarians belonging to all three coalition parties (CDU, CSU and the FDP). If this happend in the UK it would be labelled an outright "rebellion" against the government.

According to Märkische Allgemeine, the Bundestag gave its consent to a permanent eurozone bail-out fund, a European Stability Mechanism (ESM), which would take over from the EFSF in 2013. However, it attached a number of strings, including:

- strengthened stability and growth pact- guarantees for the independence of the ECB- safeguards that the ESM would only be activated in emergency cases- a mechanism which would involve private creditors in the rescue fund (unclear how this would work)- a restructuring procedure which would include private creditors- a guarantee that the eurozone would not turn into a transfer union.

If you think about it, those are not small thing to ask for in the current climate. This one could be interesting.

Wednesday, March 16, 2011

Negotiations on the shape and form of the eurozone's permanent bailout scheme - the "European Stability Mechanism (ESM)" - are entering a crucial phase. The fund is meant to be up and running by mid-2013 and is likely to have €500bn available. Of this amount, between €80bn and €100bn will be up-front cash from member states - the rest will come in the form of guarantees.

People are naturally getting nervous about this arrangement, particularly in Germany. Sueddeutsche suggested the other day that German taxpayers will need to contribute between €18bn to €25bn to the scheme in paid up cash (in addition to the guarantees).

Chancellor Angela Merkel isn't too keen on discussing how much Germany might have to contribute in the end. "She doesn't want to talk about this now", a diplomat reportedly said.

We can see why. A direct €25bn liability on Germany's books could increase the country's borrowing costs and hamper efforts to consolidate its budget.

To avoid this, the German government is pushing only for countries without a triple A rating to contribute paid-up cash, as triple A countries - so says Merkel - are lending their good name to the cause, and that's quite enough. But this, in turn, would increase the cash contributions from weaker eurozone members. This has raised alarm bells amongst weaker euro economies as well as a range of non-eurozone members.

Reuters yesterday quoted EU sources saying that eurozone members Estonia and Slovakia as well as Latvia, Lithuania, Bulgaria and the Czech Republic have all criticised the plans. They argue that basing cash contributions to the ESM on a country's proportion of the ECB's paid-up capital is unfair. The countries have even threatened to block proposals for tougher EU-wide budget rules unless changes are made to the suggested ESM arrangement. One representative said,

"Unless there is a change to the ESM capital key we will block the agreement on the governance package once it returns from parliament and EU finance ministers have to approve it by unanimity."

Also non-euro member Sweden has objected to the proposed capital key for the ESM.

Why do these countries feel so strongly about this issue. They're not in the eurozone after all? Well, probably because they understand that, were they one day to join, they could be forced to cough up actual cash to save a Greece, Ireland or Portugal. Paid up cash is a far more serious liability than loan guarantees. Slovakia's refusal to take part in the Greek bail-out gives a hint as to why these countries aren't thrilled by the prospect of a permanent bail-out arrangement linked to the ECB's capital key and credit status. In such an arrangement, smaller economies that haven't really done anything wrong could end up with a pretty hefty bill.

On a related note, where is the UK in all of this? So far, the UK appears to have taken little interest in the structure and pay-in arrangement of the permanent bail-out mechanism. If this is because it doesn't intend to ever join the euro, that's one thing.

But if it's because Britain thinks it has no stake in making sure that the new eurozone rules are fair and make economic sense - rather than facilitating even greater meltdowns down the road (a very real risk) - then the UK government is sadly mistaken.

Mundane issues such as these should not, of course, distract from the really important issue - maintaining MEPs' €180 million/20,000 CO2 a year Strasbourg seat (in addition to their ordinary seat in Brussels and their secretariat in Luxembourg).

At least, that's how France sees it. The French government has said it will challenge the decision at the ECJ, taken by a majority of MEPs to scrap one - we repeat just one - of Strasbourg's annual sessions (the EP holds two plenary sessions in the autumn to compensate for MEPs' extended holiday season.)

The French Europe Minister Laurent Wauquiez explains why:

"The parliament building in Strasbourg is the symbol of a Europe closer to citizens, a Europe that is proud of its symbols. The government will not accept the knife-attack on the contract which is in the treaties."

Monday, March 14, 2011

The Telegraph's Ambrose Evans-Pritchard describes the weekend deal at the EU summit as a "total German triumph". He paraphrases Chancellor Angela Merkel saying that "whoever wants credit must fulfil our conditions".

Regular readers of this blog will know that we rate Ambrose very highly (at a time when most other journalists, including the FT gang, couldn't spot a currency-related credit crisis from a yard's distance, he warned against what we've seen in the eurozone over the last year).

On this one, however, we think that his assessment might be a bit premature.

Perceptions matter tremendously in markets as well as in politics. And the perception in Germany is certainly not one of triumph.

Die Welt quotes a top EU diplomat describing Merkel's "pact for the euro" as an "empty shell", predicting that "in the coming weeks the spreads of troubled countries could further increase". An analysis in the newspaper notes that the pact "remains far beneath the original expectations of the German government", given the large room for manoeuvre that member states are given in its implementation. The headline in the paper reads: "Merkel's secret euro capitulation".

And Merkel might even face a fight within her own coalition about the terms and crucial details of the euro pact.

Although FDP leader and Foreign Minister Westerwelle called the deal an acceptable compromise, liberal MP Frank Schaeffler said that "the result contradicts the position of the FDP group in parliament”. Volker Wissing, finance spokesman of the liberal faction in the Bundestag stressed that an earlier agreement on this among majority parties in the Bundestag "had excluded what has now been decided at government level", as he expected "very difficult talks", which could endanger the German Parliament's approval of the deal.

"It is surely close to a transfer union," Michael Meister, deputy parliamentary leader of the Christian Democrat (CDU) party added (and it was not meant as a positive remark). CSU MP Thomas Silberhorn bluntly said that "the government has stepped over a red line that the parliamentary groups had clearly defined."

Just ahead of the summit, another top Christian Democrat politician, Bundestag Speaker Norbert Lammert, had voiced concern about the whole thing, lamenting that "many representatives still don't feel sufficiently informed".

It is not clear whether these (prominent) backbenchers will in the end vote down the agreement. Bloomberg claimed this afternoon that several backbenchers have signalled their willingness to vote for the deal when it reaches the Bundestag.

But the strong talk is a reminder of the nervousness about all of this in Germany, especially in the run-up to the key regional elections in two weeks time in Baden-Württemberg - a stronghold for Merkel's CDU where the party could now suffer defeat.

It doesn't help that outgoing Bundestag President Axel Weber has stepped up his criticism of current eurozone policies. In a hearing at a Bundestag committee this week, he will warn European governments against making any bond purchases as a means of bailing out weak Eurozone countries, saying

"the result would be that private creditors and national financial policymakers would be relieved even further of their responsibility, and taxpayers of the countries doing the financing would be burdened with further, possibly substantial risks."

Chances are that Merkel will manage to push through this deal in the short term - though the German Parliament may demand some red meat in return for giving its approval.

Some members of the German establishment have already started questionning the very premise on which Merkel has based her bail-out concessions (saving the euro, even with the risk of more bail-outs and a move away from traditional Bundesbank policy is cheaper than refusing to pay). For example, the former boss of the German industry federation BDI, Hans-Olaf Henkel. Although a former euro enthusiast, he now argues in favour of splitting up the eurozone, writing that it has become “a transfer union, a community of redistribution in which a new competitive discipline will emerge: who can tap the others for the greatest amount."

Berlin's biggest fear is that Mr. Henkel is finding it increasingly easier to recruit more allies.

Much was discussed and a little agreed during Friday’s eurozone summit, but it was enough to give the euro a bit of a boost. Investors - going into the weekend with exceptionally low expectations - seemed pleased with the news that anything was agreed at all.

The most important and controversial measure agreed over the weekend looks to be allowing the EFSF - the eurozone's main bail-out fund - to purchase government debt, under exceptional circumstances.

The conditions imposed on any country wishing to make use of the EFSF's bond-buying scheme are pretty exceptional as well:

- EFSF can only buy bonds on the primary market (i.e. directly from governments)- For this to take place, the government must enact an austerity programme as it would under a bailout

So what exactly is the difference between a bailout and using the EFSF to buy government bonds under these conditions? Not much, as far as we can tell.

One argument behind restricting purchases to the primary market is that it bails out governments rather than investors. Although that might be true, if the EFSF did purchase bonds in the secondary market the cost of borrowing for peripheral governments would undoubtedly fall by a lot more. There is also the added advantage of purchasing existing debt rather than issuing new debt and increasing the already heavy burden. In the end it looks like the standard EU compromise where both sides meet somewhere in the middle to achieve very little.

The decision also means that the ECB could well be forced to continue buying bonds on the secondary market, since a struggling country will think twice before signing up to strict conditions in return for the EFSF relieving them of some of their junk bonds.

What is significant, however, is that there are now three avenues through which the cost of failing economies can be transferred onto EU taxpayers - about a year ago, there were none (remember the days when some of us were foolish enough to believe that a guarantee in the EU Treaties, i.e. the no bail-out clause, actually meant something?):

1) Direct loans from one of the bail-out funds (requiring unanimity or a majority vote amongst eurozone governments)2) The ECB buying government bonds, from the secondary market (at the discretion of the ECB)3) The EFSF buying government bonds, directly from governments (unclear how decisions will be reached on when this can happen).

Many of the key questions remain, however. Such as:

- What interest rate will the EFSF be charging on government bonds purchased?- Will this option be open to countries who have already received a bailout?- How will the activation of the EFSF's bond purchasing programme be decided?- Will Merkel be able to see this through amid domestic political resistance?

We’d hazard a guess that the EFSF would charge below market rates but above its lending rate, but we’d also expect some differentiation from the bailout loans otherwise it would look completely pointless.

Apart from that, we note that Greece - as we expected - has been granted what can only be described as a debt restructuring, though a limited one.

So on the upside, markets are slightly more re-assured. On the downside, expectations are now raised that a meaningful deal will be struck at the summit in two week's time.

When you do scratch the surface, this looks perilously close to more of the same.

1. The Czech Republic considers today’s meeting as very important and timely. We support the measures, including sanctions, that have been introduced up till now on the side of the EU.

2. However, when we looked at the draft of the declaration, we did not find it very persuasive. There is no clear signal coming from it. Short-term and medium and also long-term goals and ambitions should be differentiated. I suppose we have met here today mainly because of the acute situation in Libya, which means we aim at a short-run. Of course, we must be able to see it in a wider and longer perspective and strategically, we have to know what to do not only today, but also tomorrow and day after tomorrow. Some of us attended the EU-Africa summit in Libya last November. I am afraid some of us did not see the crazy nature of Gaddafi’s regime and did not behave in a way which justifies our current strong words.

3. The Czech Republic is convinced that we have to try to help to stop the humanitarian tragedy in Libya now, but without intervening militarily in Libya or any other country, without picking up potential new leaders etc. In this respect we consider the recognition of the “Benghazi” Council at least premature, if not basically wrong.

4. We should be aware of the long-term consequences of our decisions. I warn – and that is the position of the Czech Republic – against talking about a no-fly zone because there is nothing like that. No-fly zone means a war because it requires to destroy both Libyan aircrafts and helicopters and Libyan air defense. It is a war. The pressure we should make is the resolute requirement for Qaddafi to step down without negotiating with him. I stress stepping down before negotiations, this sequencing is absolutely crucial. Unconditional surrender is the only possibility. We should make it very clear.

5. Several side-remarks:- It seems to me it is necessary to warn against comparing the situation in Northern Africa now with Central and Eastern Europe 20 years ago (Buzek), at that time the “rebels” (Orban, me) had clear views about the future, I am not sure it is the case in Egypt or Libya now;

- The experience with one of the institutions which were hastily established after the fall of communism in 1989 – the EBRD – is visibly negative. It has never been a real help to the countries in my region. We are, therefore, very much against creating another similar bank, we suggest to delete the idea of the “Bank for the Mediterranean” out of the text;

- On the contrary, we suggest to include one idea into our declaration which is not there – our long-term help should be offering the North African region open markets in Europe;

- I heard, in our meeting before lunch, the term “Gaddafi’s money”. It reminds the attempts to find “communist bosses’ money” in our part of the world. Nothing like that exists.

EU leaders - still visibly split - have just agreed on a trade-marked "least common denominator" statement on Libya, following today's summit in Brussels. Speaking at the end of the summit, David Cameron said that the EU's 27 leaders were "united, categorical and crystal-clear" that Gaddafi had to go - which is a welcome statement (Gaddafi is a maniac after all) but not much different to what the EU leaders who matter had already called for.

In terms of substance, EU leaders agreed new sanctions against financial institutions linked to the Gaddafi family, adding the Libyan Central Bank and Libyan Investment Authority to the EU asset-freezing list. It also agreed that "contingency planning" involving "all options" should continue, in case Gaddafi and his LSE-educated son, continue to act crazy.

The communique didn't refer to a no-fly zone, however, despite Nicolas Sarkozy calling for "defensive" and "limited" air strikes - something he said he had British support for.

"We the French and the Britons have given our availability – under the explicit condition that the United Nations want it, the Arab League agrees to it and the Libyan Authorities that we want to be recognised wish it – to carry out targeted, purely defensive actions, and only in the event that Mr. Gaddafi used chemical weapons or the aviation against people who are demonstrating without violence."

The reluctance of other leaders to subscribe to this reasoning means that the UK and France were sidestepped on this point. The EU remains all over the place on a no-fly zone (and France still stands alone in recognizing the Libyan opposition).

This also appears to be the first time that Cameron has openly clashed with EU 'foreign minister' Cathy Ashton, who according to PA, is now warning against a no-fly zone. An EU diplomat is quoted saying:

The efficiency of a no-fly zone is very questionable. Apart from anything else, European command and control facilities would not be able to get a no-fly zone up and running in less than five or six weeks, and Nato is suggesting it would take at least three to four weeks.

All of this is of course being played down by Downing Street.

That the EU's two most credible military powers and only permanent members of the UN security council are seemingly at odds with the other 25 member states illustrates the limitations on the EU's foreign policy ambitions. Although a no-fly zone would almost certainly require US approval and firepower, in Europe, the UK and France are the only game in town if things get really nasty. But still, everyone must be included, no one left out.

Today's meeting was all about EU self-assurance and will have little bearing on on how things turn out on the ground.

Attempts to create a common EU foreign policy rest on the notion that a single, clear voice emanating from Europe would carry more weight than a shrill, discordant cacophony of individual voices from member states. This is appealing in principle, but as we've argued again and again - it cannot be achoeved artificially.

During the unrest in Egypt, we noted that when Europe does indeed “speak with one voice”, it takes a painfully long time to co-ordinate, and usually results in a bland, anodyne statement. This is because the national interests of 27 member states have to be amalgamated, so as not to prejudice any of their divergent interests in wider international affairs.

Yesterday’s unilateral decision by France to recognise the Libyan rebels in Benghazi as the legitimate representatives of the Libyan people made for some lively discussions between the EU’s foreign ministers and some enlightening press briefings.

During “an unusually candid” press briefing, German foreign minister Guido Westerwelle said he had been sitting next to his French counterpart Alain Juppe when the news broke, and that Mr. Juppe later complained that he had not been pre-notified, and that Mr Sarkozy appears to have acted "on a whim".

Italy distanced itself from the French position, with foreign minister Franco Frattini saying the UN and EU should send new fact-finding missions to Benghazi before making any decisions, while Belgian foreign minister Steven Vanackere said there is a “difference between engagement and recognition”. Sweden’s foreign minister chose a direct route of registering his bemusement at France’s circumvention of diplomatic norms by tweeting:

“Sweden recognizes states - not regimes. And most other EU countries are the same. Somewhat unclear on what France does.”

The confused state of affairs is further exacerbated by the fact the EU is trying to decide what line to take on a possible no-fly zone which might involve air strikes against Libyan military targets, which the European Parliament has urged them to do yesterday, with Labour MEP Richard Howitt warning that that EU states must “be prepared to change the current rules of engagement on whether military measures are required against colonel Muammar Gaddafi's regime”. Today, David Cameron and Nicolas Sarkozy sent a letter to EU Council President Herman van Rompuy which took a decisive position on the Libyan position, arguing:

“the deliberate use of military force against civilians is utterly unacceptable… when the Libyan people win their fundamental rights, we should be ready to support them with the necessary assistance and cooperation”.

Meanwhile, Euobserver has reported Baroness Ashton's people are not keen to visit Libya due to the volatile security situation in the region, prompting the question “what is exactly is it that they are paid so well to do?”

The confusion over Sarkozy’s decision to recognise the Libyan opposition unilaterally, and the lead taken on the Libyan crisis by France and the UK in general have yet again highlighted the difficulty, some would say futility, of assembling a common EU foreign policy.

Let's hope that EU leaders can come up with something more coherent at today's summit.

Over on Europe’s World we have a post on the future of Portugal. We argue that a bailout now looks inevitable but that it will do little to solve Portugal’s problems due to:

- Funding requirements topping €39.4bn this year alone, equal to 25% of GDP.- Unsustainable borrowing costs both in the short term and the long term, as we have already noted.- Over reliance on ECB funding - both the state and the banking sector- Massive lack of competitiveness as well as few policy options to facilitate economic reforms and foster growth

Given the mountain of issues facing Portugal, a bailout might give the appearance of providing help in the short term, but restructuring debt and tackling the problem at its source - high debt to GDP ratio and massive amounts of private debt - will provide a much better long term solution for both the country and the eurozone. However, even so, in the absence of some serious reforms to boost the country's competitiveness, going far beyond those that we're seeing at the moment, Portugal may find itself in this position again before too long.

As we've noted before, the EU is in desperate need of a single patent - virtually overnight, such a patent would boost competitiveness and growth and attract innovation, not least by cutting costs for SMEs. It's currently around 15 times more expensive to obtain a patent across the EU than obtaining patent protection in the US. Or to illustrate using other estimates: a patent validated in 13 EU countries costs as much as €20,000, of which nearly €14,000 arises from translation alone (according to the European Commission).

So it was welcome news when EU leaders agreed to press ahead with an EU patent, despite the silly opposition from Spain and Italy.

But apparently, the ECJ - the omnipotent (or so it thinks) EU court seated in Luxembourg - has different ideas. It now says that establishing a new court to judge patent litigations - which was part of the proposal for a single EU patent - is incompatible with EU law.

The ECJ is worried that giving some judiciary powers over patents to a 'non-EU institution' raises questions over....wait for it...checks and balances.

We don't suggest that EU law is arbitrary (not that we would), but let's see if we got this straight. Establish three new EU financial supervisors - through a qualified majority vote - with binding powers over national supervisors in seven broad areas, and the mandate to interpret (i.e. quasi-judicial powers), apply and enforce provisions in over 20 separate EU laws (including initiating dawn raids against individual firms in the case of credit rating agencies) is no problem. But it's not okay to establish a Court looking only at patents? Meanwhile, it's okay to switch legal bases in various ways (data retention magically becomes a Single Market issue, eliminating national vetoes, working time becomes a health & safety provision, etc.).

There's a huge amount of arbitrary government in the ECJ's reasoning. If the Luxembourg judges were consistent, we would applaud their new found appreciation for checks-and-balances, but they're quite clearly not.

Sadly, it's the European economy and recovery that will suffer.

Now, if it is indeed the case that the ECJ is concerned about a body whose status as a non-EU institution is unclear, and about the absence of clear guarantees about how it would be bound by EU law and what kind of checks and balances would apply to it - which were all concerns flagged by the ECJ - then such concerns must apply to other bodies with similar a status as well, correct?

As it has turns out, the European Financial Stability Facility - the eurozone's €440 billion bail-out fund - is a non-EU institution, it's unclear whether it's bound by EU law (i.e. the no bail-out clause) and it's even more unclear what checks and balances apply to it (for certain no Parliamentary control).